Tuesday, February 7, 2012

A lot went wrong with the specific case of Solyndra. I'm not deeply familiar with the details, but Bob provides a lot of great context in his recent article.

What I'm a little more hesitant about - stepping back from the specific case of Solyndra which is an example of corruption that could occur in any bureaucratic institution - is this section:

"Federal Loan Guarantees Inefficient, Even When a "Success"

Despite the efforts to cast Solyndra as a lone bad apple, the Department of Energy has guaranteed other renewable energy projects that later collapsed. However, even if the DOE program had always backed "winners"—meaning that no borrower ever defaulted, and so taxpayers never contributed a dime—it still would have encouraged an inefficient use of resources.

As the White House staffer's email ironically illustrated, the reason that firms such as Solyndra need government backing is that private investors think the loans are too risky. When the government comes in and, in effect, co-signs on the loan, this doesn't remove investors' original doubts. Rather, it simply leaves the taxpayer on the hook should something go wrong, while private investors get to keep their gains if everything goes right. (The Solyndra case is even more convoluted because much of the federally guaranteed loan amount came directly from the Federal Financing Bank, part of the Treasury.)

Government loan guarantees do not create more physical resources and do not (by themselves) induce individuals to save more. Consequently, when the government backstops a particular loan that would not otherwise have occurred, it draws scarce funds away from other projects that private investors originally preferred, all things considered. Unless we have some compelling reason to believe that politicians and their staffs are more careful with taxpayer dollars than private investors are with their own money, such loan guarantees will cause investment to be deployed into inferior uses. "

Every loan guarantee program is going to have some defaults. We all know this - whether the guarantor is public or private, they know this. If we didn't all know that was going to happen there would be know such thing as loan guarantees. There would be nothing to guarantee! So let's scurry past that first sentence.

Why does Bob think that the fact that private investors are not interested (not really true... in many of these cases private investors would be interested but the cost of the credit would be higher) implies that the use of resources in this way would be inefficient? He seems to act as if the counter-argument - that negative externalities associated with the production of energy and positive externalities associated with research and development - make private allocation of funds inefficient. Private investors, remember, are concerned with their evaluation of profit opportunities. Bob is simply wrong to say that these loan guarantees "would have encouraged an inefficient use of resources". No one can say that with certainty (although we can all offer educated guesses), and there's certainly nothing about the decision-making of private investors that guarantees this.

I'm also baffled by his concern about drawing away scarce funds.

But the icing on the cake is Bob's pre-condition for loan guarantees like these: the claim that we would need to expect politicians to be more careful with taxpayer dollars than private investors are. This simply isn't required for someone to back a loan guarantee program of any sort. I certainly don't expect this of politicians. What I expect is that private investors are great at looking after their own profits, which in many circumstances is the best way to guarantee what I would consider to be an ideal allocation of resources. But in the cases where it isn't, my standard for supporting a public program isn't that politicians "know better". Of course they don't. It's that I can trust that they can cautiously nudge the market in a direction that corrects for an externality. Market allocation will still prevail when loans or investments are subsidized (or taxed). Nobody is propping bad companies up like they might in a country that does do central planning. The price of capital or other inputs and outputs may be tweaked to reflect externalities, but the market still makes allocative decisions.

It's like with carbon taxes. All a carbon tax does is reflect the fact that we do not, in fact, have a guarantee of the efficiency of market allocation and we have reason to believe it is biased in a certain direction. The tax reflects that bias, but the government doesn't allocate anything. The government doesn't decide who gets gasoline and who doesn't under a carbon tax. It's not an allocater. Themarketallocates.

If we're going to talk about these things we should be clear about exactly what the arguments are.

UPDATE: To clarify, it's a great article. I learned a tremendous amount from it. Bob's position is also one that he can ably defend. What struck me was the discussion acted like his position was common sense and that the economics of these issues are in complete agreement with him. I understand he might not want to get into the counter-argument. That's fine. But that doesn't mean his argument is as common sense economics as it's put out there to be.

UPDATE 2: I want to re-emphasize how sincere I am in the first update. It is a good article. And the title of this post was more to motivate the discussion. Of course Bob knows about this stuff. The most problematic section is that particular section. He does raise externalities elsewhere in the article. But what he says in that section about private investors is simply not supported by anything in economics. Whether private investors will or will not invest in something tells us only one thing: their expectations of profit opportunities associated with it. That's all it tells us, period. This is wrong no matter how you cut it and no matter what else is in the article: "Unless we have some compelling reason to believe that politicians and their staffs are more careful with taxpayer dollars than private investors are with their own money, such loan guarantees will cause investment to be deployed into inferior uses". The sentence is simply untrue. I'd say "misleading", but I think that has implications of intent which I wouldn't ascribe to Bob.

The tax, though, influences how resources are allocated. Yes, there is still allocation through the (distorted -- for better or worse) price system, but this doesn't say anything towards whether or not the allocation is efficient.

If the Solyndra deal was so bad, I wander what an honest evaluation of AIG's management (or all the bailed out banks and investment banks, would return)?

Second, doesn't an honest discussion of Solyndra require a discussion of China's support of Solyndra's competitors and why China's investments are paying off? Why is the Chinese gov't so able to pick winners?

Third, to be really honest, doesn't a discussion of Solyndra require one to throw away their IPhone, for the unhappy fact is that the IPhone is built in a factory building that, as the recent NYTimes story noted, was built in advance by the Chinese Gov't.

Last, to be really really honest, doesn't a discussion of Solyndra require one to look at the substance, and not the form, of all the state subsidies of non-union factories in the SE through various schemes (tax cuts, industrial development bonds, tax credits) which gutted our great northern mfg. cities?

I was just recently debating this issue on a South African website. Since my brain is pretty poked from the 10 page macro assignment that I've just handed in, I'll simply copy-paste a relevant section:

...[T]here's no debating the fact that Solyndra has become the poster child for failed Government involvement in spurring energy innovation. Interestingly enough though, the overall portfolio of the US DOE’s Loan Guarantee Programme appears to be in a fairly healthy state (http://bit.ly/y456d3). That being said, personally, I strongly favour investments in clean tech R&D above any kind of production subsidization (as was the case with Solyndra). In an ideal world, this production activity would be coordinated via market signals inclusive of a carbon price, but I guess you can’t have everything...

===

On the complementary roles of clean tech R&D and carbon pricing, there's always this old post.

But Bob, in that section as in the section I quoted you still treat this like a special favor rather than a loan guarantee program open to all applicants.

FHA applicants have to go through an approval process too. Does it make sense to consider them "picking winners" or should we consider it a subsidy?

Anyway - the reason why I was interested in commenting on this section specifically was because you made claims about the lack of private investor interest that don't seem to be warranted by anything we know about economics.

I could have quoted the final section too. You still write things like this: "Even if we set aside the practical problem of corruption, a small group of government "experts" does not, in principle, have all of the relevant knowledge needed to determine which projects should get a helpful assist in their funding" which I think miss the point.

Which sounds similar to the claims you were making in the passage I did decide to quote.

And perhaps my title was a little much. After all, I know you know this stuff. The article seemed to be responding to a completely different sort of counter-argument. A counter-argument that guys like stickman and I probably wouldn't make.

Daniel once again you astound me. For curious onlookers, for the record let me spell it out:

(1) Daniel titles his post, "Does Bob Murphy misunderstand the counter-argument, or is he just avoiding it?"

(2) Even after two updates, Daniel doesn't give his reader any hint that I have an entire section titled "The Problem of Climate Change," which starts with the following paragraph:

Proponents of the DOE's loan guarantees have responded to the Solyndra failure by saying that the program has been, overall, an "unmitigated success" in encouraging investment in socially beneficial renewable-energy projects that would not have occurred with purely private financing.15 In the eyes of these defenders of the DOE, the alleged "negative externalities" of climate change mean that the market economy currently yields too many coal-based power plants and too few solar- and wind-based plants.

I really have no idea at this point what more I could have done to show Daniel I was aware of the argument, and wasn't ignoring it.

Geez Bob - First - as I've said, the title is for effect - for framing. Neither I nor anyone else here seriously thinks you are unaware of the other argument.

Second - After your first concerned comment - just because you were concerned about it - I published a new update where I mentioned that you did write about externalities in another section of the article. Here's the thing - I thought there was a ton wrong with the section I did quote, which is why I quoted that section.

I'm not sure it makes much sense to take that section of Bob's article in isolation. He obviously does spend significant time addressing externalities and what an appropriate answer to externalities could be. Within that context, what he says makes perfect sense. There is a way to correct the externality which trusts market participants to pick winners and losers: tax or cap-and-trade or something like that. To instead adopt such a loan-guarantee program is an implicit statement that the DoE will be more careful with tax-payer dollars than private investors would be once a Piguvian tax has internalized the cost of carbon emissions.

I'm also surprised that you would try to compare this program to the FHA loan guarantees. As I understand it, FHA applications are largely rule-based with little opportunity for intervention by policy-makers in individual loans. On the other hand, the DoE program offered very few loans affording much opportunity for discretion by policy-makers.